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12Exploring Linkages Between Crude Oil And Indian Equities!Mar-30-2021

Exploring Linkages Between Crude Oil And Indian Equities!

Blog by – Mr. Dhruv Ajmera

Crude oil prices have been soaring recently with the commodity hitting its highest levels in last two years in first week of March 2021. This is likely making some equity trading participants think about the ability of local stocks to extend the recent rally. In India, soaring crude oil futures tend to trigger plenty of frenzy regarding fuel prices and inflationary trends given that the country imports a large chunk of oil to meet consumption. Rising crude oil also leads to soaring petrol and diesel prices and are generally supposed to lead to elevated price levels across the board. However, when it comes to stock market trading, do soaring crude oil prices tend to overwhelm equities as it is thought? Let us try to find out. 

The broad price action in Nifty and Crude oil over last decade indicates that there is a positive correlation between the local share markets and crude oil prices. This is an interesting observation though as it falls in sync with the reality that the emerging market equities are being treated as an asset class by global investors which is directly linked to the world economic growth trends. If global economy is doing well, emerging financial markets will certainly do well and as a leading emerging economy, Indian stocks will tend to outperform. 

Another critical factor at play here is the performance of oil and gas companies share prices. The Nifty Energy index which includes companies belonging to Petroleum, Gas and Power sectors has rallied around 55% over last one year, slightly outperforming the benchmark NIFTY 50 index which has returned around 43% during the same period. The Index comprises of 10 companies listed on National Stock Exchange of India (NSE). This outperformance shows that rising crude oil prices and the corresponding surge in domestic fuel prices have not weighed on stock prices of energy companies in India. Given that these are prominent commodity stocks in India, exuberance in their share prices generally augurs well for broad stock market trends. 

The record high fuel prices could, over a long term, impact the broad trends in equity market trading as elevated inflationary readings push up the interest rates and lead to lower disposable incomes in general. However, given the current environment, the consumer confidence is turning higher and the economy has just moved out of recession. The RBI has noted that economic activity is gaining steam as COVID-19 incidence recedes and the ongoing vaccine rollout releases pent-up optimism. Most stock market advisory services are also indicating good potential for local stocks over coming period. 

Conclusion:  

While the general undertone in crude oil prices is supportive, the medium term scenario may continue to see oil witnessing some resistance at higher levels. The Reserve Bank Of India has noted in a latest update that crude oil prices may remain supported by demand build up on optimism from vaccination and continuing production cuts by OPEC plus. CPI inflation excluding food and fuel remained elevated at 5.5% in December, due to inflationary impact of rising crude oil prices and high indirect tax rates on petrol and diesel, and pick-up in inflation of key goods and services, particularly in transport and health categories. However, the crude oil futures curve has become downward sloping since December 2020, the central bank stated.

Globally, oil prices have rallied by intensely after witnessing a plunge into negative territory last year. With soaring prices the increasing output response from US oil producers may cap upside in oil from hereon. The US Energy Information Administration or EIA, in its Short-Term Energy Outlook stated that rising oil prices reflect expectations of rising oil demand as both COVID-19 vaccination rates and global economic activity have increased, combined with ongoing petroleum supply limitations by the Organization of the Petroleum Exporting Countries (OPEC) and partner countries (OPEC+).

However, EIA continues to expect downward crude oil price pressures will emerge in the coming months as the oil market becomes more balanced. EIA’s forecast of declining crude oil prices and a more balanced oil market reflect global oil supply surpassing oil demand during the second half of 2021. Overall, given the fact that the Nifty 50 index has gone up by around 40% over last five months despite a 70% surge in crude oil prices in the same period indicates the resilience in local sentiments. A rangebound oil price movement from hereon will continue to augur well for the equity investors in India. 

Also Read: What Does A Spurt In Rupee Mean For Your Equity Investments?

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